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Could These Gold Producers Surprise You?

October 24, 2013

The drop in gold price in the past year has took its toll on gold producers such as Barrick Gold (NYSE: ABX) and Goldcorp (NYSE: GG). Both of these companies’ shares have tumbled down during 2013. Looking forward, however, these companies have several factors that could play in their favor so that investors, who wish to include in their portfolio gold holdings, may benefit from owning these companies. Let’s start by reviewing these companies’ recent developments.

In the second quarter, gold companies have adjusted their long term gold price. Barrickhas reduced its long term gold price on future projects to $1,300 per ounce.Goldcorp isn’t any different and it has also revised down its assumptions on the price of gold. This is why both companies had heavy losses in the second quarter. They have recorded high impairment of mining interests and goodwill provisions: Barrick’s impairment provision was $8.7 billion; Goldcorp’s impairment charges were $2.5 billion. But not all gold producers have recorded in these provisions: Yamana Gold (NYSE:AUY) didn’t have these make impairment charges in its second quarterly report. According the company’s financial reports , Yamanabelieves the drop in gold price would partially be offset by other inputs that would result in lower costs and updated mine plans.

The recent developments in the gold market including the FOMC’s decision to keep its asset purchase program unchanged and the strong demand for gold in Asia could keep the price of gold from resuming its downward trend in the near future. If gold price remains stable, these companies won’t have to record additional high impairment charges to their mines. So these companies’ performance will play a bigger role in their valuation. Let’s review some of the reasons why these companies may have some cause for cautious optimism.

Decline in costs: Barrick’s All-in sustaining costs were lower than last year’s by 13.3%. Moreover, the company’s guidelines for 2013 are also lower than last year’s, which could slightly ease the adverse effect caused by the sharp decline in the price of gold in the past year. One of the reasons for the drop in costs is the company’s sale of mines that were less profitable. E.g. the company recently sold three mines in Australia.

Higher gold production: Both companies augmented their gold production, which is likely to result in higher revenues. Goldcorp’s gold production grew by 11.6%. Most of the growth came from the Red Lake gold mines and Pueblo Viejo mine , which was opened in August last year and is one of the largest gold assets worldwide with more than 30 years; Barrick’s gold production grew by 3.9% but is likely to rise even faster in the coming years on account of its Pascua-Lama project. Alas, due to the drop in gold prices, the company reduced its capital expenditure on this project by $0.7-$0.8 billion in 2013 and by $0.8-$1.0 billion in 2014. These cuts will impede the completion due date of this project. Nonetheless, these new projects are likely to pull up these companies’ revenues in the near future.

Valuation: These companies’ valuation has tumbled down in the past several months, mostly due to the drop in gold price. The table below shows these companies’ enterprise value to EBITDA ratio, after controlling for the goodwill and impairment charges provisions that were recorded in the past quarters.

Source of Data: Google Finance, Wikinvest and Damodaran’s site

The table shows thatBarrick’s valuation is lower than the Precious Metals market average; Goldcorp’s valuation is slightly higher than the market average but not far off. This puts Barrick’s value the least expensive. In comparison, Yamana is close to the market average as it has a ratio of 7.37.

Dividend: The sharp rise in operating loss has led Barrick to cut down its dividend to an annual pay of $0.2 per stock, which means its yearly dividend yield is 1.03%. But not all companies have reduced their dividend: Goldcorp’s dividend hasn’t changed and its yield is much higher at 2.34%. Yamana’s annualdividend yield is also similar to Goldcorp’s at 2.63%. This may have been the silver lining of the staggering drop in these companies’ stock prices – the rise in their dividend yields. These dividend yields are also one of the advantages of owning gold companies over gold ETF such as SPDR Gold.

Takeaway

The sharp drop in the price of gold during the year has dragged down leading gold producers. Due to these changes, Barrick and Goldcorp have already adjusted their assumption on gold price. The potential rise in these companies’ revenues on account of their developing projects is likely to eventually pull up these companies’ revenues. Finally, these companies’ valuations aren’t high, which makes them reasonably priced.

Disclaimer:The author holds no positions in stocks mentioned and does not plan to initiate positions within 120 hours of the posting of this article. This article is to be used for educational, research and informational purposes only and does not constitute investment advice. There are no guarantees, expressed or implied, of future positive returns in regards to the subject matter contained herein. Understand the risks inherent in investing before making the decision to invest or consult an investment professional for more information. Reasonable due diligence has been performed in regards to the information in this article. However, the author expressly disclaims any liability for accidental omissions of information or errors in fact.